Introduction:
A loan is when one party gives money to another party in exchange for repayment with interest on a later date or repayment with interest over time. An investment on the other hand is the act of acquiring ownership over something with the goal of generating money using that thing, or in the hope that the item increases in value over time.
A company is usually a group of people who come together with a common goal of providing either products or services in exchange for monetary gains. But over time many non profit organizations have been formed that may come under the definition of company too. Under section 2 (20) of the companies act, 2013 “company” is defined as a company incorporated under this act or under any previous company law.
Thus, the topic at hand is about the ability of a company incorporated under the Companies act, 2013 to give out loans and invest in other companies or individuals. What will be covered in more detail is the rules that any company has to keep in mind before giving out a loan or investment. The said rules are covered under section 186 of the Companies Act, 2013 (here on referred to as ‘the act’). The 13 subsections can easily be split into different genres of regulation, as seen under each subheading of the article.
Layers of Investment [sub-section (1)]
The first subsection itself makes it clear that no company is allowed to make any investment through more than two layers of investment companies. An investment company is one which majorly focuses on acquisition of shares, debentures and other securities.
If we take company X as an operating company, which has a subsidiary investment company called company A, this company A is the first layer of investment company. Then if said investment company invests in 2 companies B & C where B is another Investment company while C is an operating company, company B is the second layer of investment company and hence company B should ideally only invest in operating companies, since subsection 1 of section 186 makes it illegal for company X to invest through more than 2 layers of investment companies. Company C on the other hand can invest in another investment company D, which shall further invest only in operating companies since the operating company C though adding a layer of company in between company X and company D, is not a layer of investment company as mentioned in section 186 (1) of the act.
This subsection would not apply to any company acquiring a company incorporated outside of India, if that company has more than two layers of investment companies in accordance with the laws of the country in which it was incorporated. It would also not apply to a company if they were simply trying to meet the requirements of any law or regulation in force at the time of the act.
Limits [sub-sections (2) (3) (7)]
There are 3 parts of a company that help determine its value, the paid-up share capital, free reserves and securities premium. The paid-up share capital is the money raised via the sale of shares to the public, usually though an initial public offering (IPO). Free reserves as the name suggests is the amount of profits lying around, that the company can draw from at any given time without creating any liabilities. The securities premium is the difference between the face value of a share of the company and the price at which they sold the share, e.g. if the face value of a share of company X is 10 rupees and they sell that share to the public at 15 rupees, the securities premium on this share would be 5 rupees. The securities premium is usually generated at later public offerings or when the owner is trying to liquidate.
So, the limit set for the amount of money a company is allowed to give out in loan or provide guarantee or security for someone or acquire in terms of subscription or securities is either 60% of the total of the 3 parts of the value of the company, or 100% of the value of the free reserves and securities premium, whichever is more. This helps make sure that the company is not giving away more money than they have. In simpler words they must save at least 2/5th of the value of the company for a rainy day at any given time. But if at any given time, the company feels it necessary to give a loan or provide a guarantee for a sum higher than as prescribed in section 186(2), they must gain prior approval of the board by passing a special resolution at a general meeting.
Another important rule to keep in mind while giving out a loan under sub-section (7) is that the rate of interest of that loan shall never be lower than the prevailing yield on government security closest to the tenure of the loan. A government security is a debt obligation by the government i.e. a promise to repay the sum of money payed for said security with added interest. The yield on government security is the rate of interest the government is willing to pay per annum until the date of maturity. The government regularly announces the cut-off yield of one-year, three-year, five-year and ten-year periods.
Full Disclosure [sub-sections (4) (5) (9) (10)]
It is important for a company to maintain transparency among the members about all the details of any loan given, investment made, guarantee given or security provided. They must not only mention the amount of money going out, but also mention the duration for which said amount is on loan or guarantee, and the rate of interest they shall receive and also the purpose for which the recipient of the loan or investment needs the money.
No loan, investment, etc. can be given without the prior consent of all the directors present at the board meeting where the resolution to give the loan or make the investment is to be passed. They also require the approval of a public financial institution in case of a subsisting term loan. If the total of all the previous loans, securities, guaranties given and investments made till date is less than the limit as specified in sub-section (2), and there has been no default in repayment of loan instalments or interest to the public financial institution, then there is no need for prior approval from the said institution.
Any company giving a loan or making a guarantee or providing security or making an investment shall maintain a register of the particulars of each transaction in the prescribed format. This register shall always be available for inspection at the registered office of the company and members of the company shall be allowed to take copies or extracts of the particulars at any time upon payment of prescribed fees.
Companies not allowed to participate in loans and investments [sub-sections (6) (8)]
No stock brokers, sub-brokers, share transfer agents, etc. registered under section 12 of the Securities and Exchange Board of India (SEBI) Act, 1992 or covered under such class of companies shall be allowed to take intercorporate loans or deposits exceeding the limits prescribed in said act.
No company in default of repayment of any deposits or in default of payment of interest on any loan that they had taken would be allowed to give out any loan or guarantee or security or make any investments till the said default is not cleared.
Exceptions to this section [sub-section (11)]
There are many situations in which the said rules may not apply, thus a few exceptions have been given within the section itself. None of these rules except the ones mentioned in subsection (1) shall apply to the ordinary course of business of any insurance company, or housing finance company, or business financing company or any company of a similar nature for which a whole separate set of laws and rules exist.
The rules mentioned shall also not apply non-banking financial companies registered under Chapter IIIB of the Reserve Bank of India (RBI) Act, 1934 whose principal business is the acquisition of securities. This is because the nature of the said business is such that they trade in the securities and shares that are allotted in a way under clause (a) of sub-section (1) of section 62 of the act. This makes it impossible for them to function in compliance with section 186 of this act, and hence there exists a separate set of rules for such companies under the RBI act as mentioned above.
Punishment [sub-section (13)]
If a company contravenes any of the provisions of this section as explained above, both the company and its officers may be punishable with a fine. The company and officers shall be liable to pay a minimum fine of Rs. 25,000/- which may extend to Rs. 5,00,000/- for the company but may extend only up to Rs. 1,00,000/- for each officer in default. The officers may also be punished for the default with imprisonment up to 2 years.
Conclusion
The said rules have been framed very well to make ethical behavior a central norm of every company, and to make tax evasion and fraud especially difficult. Every rule described makes it clear what companies aren’t allowed to do, what they are allowed to do and how. The punishment prescribed for the contravention of said rules is also apt to deter offenders. This part not only keeps in mind the security of the company receiving the investment or loan, but also the company making or giving the said investment or loan.
The section also mentions under sub-section (12) that in case the government feels the requirement at any further date to elaborate this section, they may publish a set rules to be followed by the companies while making investments, giving loans or providing a security or guarantee.
References:
- Companies Act, 2013. n.d. 4 October 2020. https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf.
- “SEBI Act, 1992.” n.d. sebi.gov.in. 4 October 2020. https://www.sebi.gov.in/sebi_data/attachdocs/1456380272563.pdf.
- “Section 186. Loan and Investment by Company.” n.d. mca.gov.in. 4 October 2020. https://www.mca.gov.in/SearchableActs/Section186.htm.
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